A significant development is now under way in the European Union (EU), which could potentially impact businesses involved in the import, export, transport or distribution of natural gas and LNG globally. The EU is proposing a set of new regulations that would, among other things, give Member States the power to limit Russian and Belarussian companies’ access to natural gas and LNG infrastructure, a move that could substantially reshape the European natural gas landscape.

The Proposed Regulatory Package in Overview

At a meeting held on 8 December 2023, representatives of the Council of the EU, the EU Parliament and certain Member States reached a provisional political agreement on a new regulatory package, which, if enacted, would introduce common internal market rules for natural gas, hydrogen and certain other renewable energy sources.
The proposed regulations are primarily designed to facilitate the penetration of renewable and low-carbon gases into the EU’s energy system – in particular, hydrogen and biomethane. This proposal comes nearly two years after Moscow’s full-scale invasion of Ukraine and is part of the EU’s broader strategy to make good on its decarbonization commitments while also reducing dependency on Russian energy sources.

As regards natural gas, a key feature of the proposed package is a regulation that would allow EU Member States to “adopt restrictions to the supply of gas, including LNG, from Russia or Belarus”.[1] Whether to implement such restrictions and, if so, to what degree, would be left to the discretion of each individual Member State. As explained in a statement the Council issued on 8 December, the aim of this regulation is to protect “essential security interests of the member states or of the EU, while taking account of security of supply and diversification objectives”.[2]

The provisional agreement reached at the 8 December meeting now needs to be endorsed and formally adopted by both the Council of the EU and the EU Parliament. These steps are expected to be completed, and the proposed regulatory package to enter into force, by May 2024.

On 12 December 2023, the Russian Federation responded through its Foreign Ministry spokesperson, Maria Zakharova, who denied that the proposed gas regulation would have its intended effect. According to Ms. Zakharova, any such move by the EU would only lead to Russian gas supplies being redirected to emerging markets, which would avoid any meaningful negative impact on the Russian economy. To the contrary, Ms. Zakharova added, the proposed regulation is more likely to harm the EU’s own economy by cutting off competitively priced Russian natural gas supplies.

Potential Impacts on European Gas Markets

The proposed regulation enabling EU Member States to limit Russian and Belarussian access to natural gas infrastructure could significantly disrupt the European natural gas markets.

While the EU has been gradually reducing its dependency on Russian energy, it still gets about a tenth of its gas supply, including LNG shipments, from Russia. Several Member States, including Austria, Hungary and Spain, still heavily rely on Russian supplies. The new regulation may prevent EU energy companies in these and other jurisdictions from performing their existing natural gas or LNG supply contracts with Russian exporters, potentially in a manner that could minimize the contractual consequences that such non-performance would typically attract:
• Contracts for the importation of natural gas commonly operate on a long-term, ‘take-or-pay’ basis, meaning that the buyer commits to purchasing a stipulated minimum quantity of gas annually (and sometimes seasonally), regardless of whether the buyer takes physical delivery of the stipulated quantity, and over a period spanning several years or even decades.
• Buyers are thus obliged to pay for the agreed-upon minimum quantities, regardless of market conditions. This structure, alongside other clauses regulating the parties’ payment and off-take obligations, tends to strongly discourage any non-performance by the buyer.
• However, depending on the specific terms of their supply contracts and/or the governing law, buyers may be able to avoid performance in certain circumstances with limited or no consequence – for example, in case of a contractually-defined force majeure event, where continued performance imposes hardship on the buyer, or where performance otherwise becomes unduly onerous or practically impossible.
• Presumably, the drafters of the proposed natural gas regulation had precisely this possibility in mind: a law that would prevent Russian natural gas from transiting European pipelines or being delivered at European LNG facilities would make it impossible for buyers to meet their off-take obligations, potentially excusing the buyer’s non-performance through legal or contractual mechanisms like those described above.
• If this is indeed the logic underpinning the EU’s proposal to limit Russian and Belarussian access to European gas infrastructure, it appears to track the reasons European natural gas importers have given for their reluctance to limit their purchases from Russia in the wake of Russia’s invasion of Ukraine. For example:
• Naturgy, Spain’s biggest natural gas buyer said in February 2023 that early termination of its 22.5 billion-cubic-meter-per-year contract with Russia’s Yamal LNG plant would require a sufficient legal reason, and that there currently was none. In this connection, Naturgy’s CEO, Francisco Reynes emphasized that “Naturgy does two things – comply with its commitments and carry on with them to the very end”.[3] • France’s TotalEnergies, who also has long-term contracts for the supply of LNG from the Yamal facility, said in December 2022 that “… unilaterally denouncing our long-term gas contracts with Russia would force the [Total] group to pay 40 to 50 billion in penalties”, and that this is “not reasonable” [translated from original French].[4] • Shell plc, in a press release delivered on 8 March 2022, committed to “start [a] phased withdrawal from Russian petroleum products, pipeline gas and LNG”, noting that this “is a complex challenge” and that “[c]hanging this part of the energy system will require concerted action by governments, energy suppliers and customers”.[5] • If the proposed package is enacted, and if Member States decide to implement the regulation limiting Russian and Belarussian access to European natural gas infrastructure, this could have significant impacts that ripple throughout the European energy markets and beyond:
• First, the need for European natural gas importers to diversify their supplies would be accelerated in order to replace quantities of gas currently supplied by Russia – either via pipeline or as LNG. This could lead to a scramble for new supply contracts over a relatively short term, with alternative sellers (notably in the US, Qatar, Algeria and Azerbaijan) having substantial leverage in negotiating the terms of those contracts.
• Second, as Russian gas supplies are cut off, gas prices – and potentially, the prices of other, alternative energy sources – are likely to increase throughout the continent. At this early stage, it is difficult to gauge how energy prices will develop, either in terms of timing or extent. However, the price volatility seen when European buyers first started moving away from Russian supplies following the invasion of Ukraine suggests that these price increases could be both rapid and significant. Among other things, this could lead to a new round of gas price reviews in Europe.
• Third, a sudden curtailment of Russian natural gas supplies to Europe could also increase the risks associated with stranded assets. Much of Europe’s existing natural gas infrastructure is already at risk of becoming stranded due to decarbonization. A policy like the one proposed by the EU could make matters worse by incentivizing the construction of new, non-Russia-dependent natural gas infrastructure in the short term, the utilization of which is likely to decrease considerably as decarbonization gathers steam.
• Recommendations for Preparedness

Given these developments, companies who may be impacted by this policy change should consider the following steps:

• Supply Diversification: To the extent not already underway, steps should be to taken to replace current Russian natural gas supplies with alternative sources. While there is already substantial pressure pushing European natural gas importers in this direction, the proposed EU regulatory package, if fully implemented by Member States, could cut off access to Russian gas in a relatively short timeframe. European buyers need to be prepared for this possibility – among other reasons, to ensure they are able to meet their downstream contractual commitments.
• Political and Market Intelligence: To optimize preparedness, potentially impacted companies should use all available sources of intelligence to understand, to the extent possible, the position of any Member States relevant to their business (in particular, with respect to the likelihood that those States will implement the proposed regulation), as well as the range of possible market impacts.
• Contract Review: Existing contracts with Russian and Belarussian sellers should be carefully analyzed in order to understand how they will interact with the proposed regulation. Special attention should be given to any force majeure, hardship and termination clauses, as these could minimize risks flowing from the buyer’s inability to take deliveries as a result of the curtailment of Russian or Belarussian supplies. Relevant principles of the applicable law should also be considered – for example, for English law contracts that are impacted by the proposed regulation, the doctrine of frustration might excuse the buyer from continued performance.
• Preparing for Possible Disputes: The litigiousness Russian interests have exhibited in response to sanctions and similar policies suggests that Russian gas suppliers are unlikely to accept the consequences of the proposed EU regulation without a fight. Disputes should be expected and properly planned for regardless of the extent to which companies consider themselves protected by the terms of their contracts and applicable law.
• Risk of Litigation in Russia: In the disputes context, it also bears noting that a 2020 amendment to the Russian Arbitrazh [i.e. commercial] Procedure Code purports to give Russian courts exclusive jurisdiction over certain disputes involving sanctioned entities, or which otherwise arise from or are connected to sanctions. Thus, depending on the circumstances, it is conceivable that a European natural gas buyer that ceases to perform its supply contract with a Russian seller could face litigation before the Russian courts regardless of whether the parties’ contract contains an arbitration agreement. European buyers should be aware of this risk – especially those with assets in Russia, which could be subject to attachment.
We will continue to monitor this situation closely and will provide additional updates as necessary. In the meantime, we would be pleased to answer any questions or to provide further analysis.
Source: By Mr. Alexander Marcopoulos, Counsel in Shearman & Sterling’s International Arbitration Practice Group, https://daily.nb.org/arthrografia/eu-contemplating-regulation-to-shut-out-russian-gas-overview-of-proposed-changes-and-roadmap-for-readiness/